FlowPoint Research – FACTOR WATCH

Summary

  • The most effective factors in stock performance for U.S. stocks YTD are revenue growth, share price momentum and estimate revisions. “Value” measures have been the biggest detractors to performance, causing angst and (loud) complaints from the bowtie crowd.
  • Interestingly, this was also true of equity styles during the period around the Spanish Flu pandemic of 1918-1919. Excellent paper here by Robeco and Erasmus University outlining the details https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3564688. Findings concluded that low-volatility and momentum tend to reduce losses during sharp market selloffs. By contrast, smaller stocks with high yields (value) offer less protection, but perform well during the recovery phase.
  • Less noticed today is the significant factor in stock underperformance by the Buyback Kings – those companies that buy back the most of their own stock and have been doing so for years.
  • This is significant because buybacks have been a massively important factor in share price performance since 2005 for all stocks. And the further back in time we look, the more important buybacks have been to share price performance. This radical change is likely to continue in our view.

Using the Russell 3000 Index as proxy for U.S. stocks, we analyzed factors on a sector-neutral basis. Neutralizing the sectors means we aren’t comparing price to book value of bank stocks versus biotech stocks; we’re analyzing banks’ price/book value vs. those of other banks, and so on.

Over the longer-term (seven and 15-year periods), value and share buyback factors have been significantly positive contributors to share price performance (it is only recently that value has lagged significantly). In 2020 however, investors have rejected the Buyback Kings’ financial engineering, and focused on companies exhibiting organic growth. 

Companies with high debt, high short interest, high volatility, and overbought technicals have been consistent losers over the short, medium and long-term (one, seven and 15 years). Interestingly, high dividend payers have also been among the worst-performing in every time-period. 

High short interest has never been a factor to bet on despite its popularity as a potentially bullish indicator.  For good reason.  Contrary to popular mythology, short-sellers appear to uncover underperforming companies, frauds and melting ice cubes before the broader market.  Additionally and unsurprisingly, buying overbought stocks (high 14-day RSI) has also been a consistent loser in every period. Someone alert the new accounts at Robinhood and the momentum chasers on Reddit’s r/Wallstreetbets.

The most consistent factor common to the best-performing stocks over each time period exhibited positive revisions in sell-side price targets and positive EPS surprises. Indeed, our own large cap portfolios are heavily skewed toward this factor.  Stocks with high profit margins and returns on capital also beat the market over the one, seven and 15 year periods, though those same factors have faltered this year.

Back to the Buyback Kings.  That list is riddled with energy and Old-World financial companies (we’re including real estate in with that bunch). That should surprise no one. With energy under pressure since 2015 (financials arguably too), it is not surprising that desperate management teams were and are looking to shore up sagging profit per share calculations by reducing the denominator. We’ve written elsewhere on the need to invest with management teams in industries with high returns on capital.  Nothing we are seeing now makes us change our belief.  What also hasn’t changed are other tried and true investment maxims.

Appendix

The best 50 S&P 500 stocks YTD have very low levels of share buybacks

The worst 50 S&P 500 stocks YTD include many of the Buyback Kings

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